The Bank of England hiked rates for a sixth consecutive meeting Thursday.
The 50bps move was the largest since 1995, prior to independence. The vote was 8-1.
Markets expected the move, as did most forecasters. At the June gathering, the Committee pledged to be “particularly alert to indications of more persistent inflationary pressures” and promised to “act forcefully in response” if necessary.
The largest hike in 27 years (figure below) apparently counts as forceful, even as the BoE still trails some of its peers on the path to restrictive policy — assuming that’s the destination.
For many observers, June’s 25bps move felt underwhelming given the scope of the UK’s inflation problem. I called the bank “hopeless and hapless.”
In the BoE’s defense, the UK has a growth problem too, something the bank emphasized in explicit terms on Thursday, when officials warned the country could experience a prolonged recession exacerbated by the steep rise in energy costs linked to soaring gas prices.
The new statement was dire. “The United Kingdom is now projected to enter recession from the fourth quarter of this year,” policymakers said. “Real household post-tax income is projected to fall sharply in 2022 and 2023, while consumption growth turns negative.”
Once again, the BoE revised its inflation forecasts higher. CPI is seen exceeding 13% in the third quarter and staying close to that through year-end. The BoE projected Q3 2022 CPI inflation would be 3.3% at its August 2021 meeting. So, its forecast was off by almost 10 percentage points.
The figure (below) is highly unfortunate, and underscores the extent to which inflation is now stochastic. These forecasts are meaningless. Note that the BoE now projects a sizable undershoot versus target in 2025, when inflation will run just 0.8%.
The bulk of the upward CPI revision was attributable to energy and “indirect effects from energy prices” on both goods and services. “Typical annual household fuel bills are projected to rise by around 75% in October when the [energy] price cap is next reset,” the bank said, referring to Ofgem. “That would mean those bills are three times higher than a year earlier.”
The juxtaposition between persistent (and now upsized), rate hikes, and the rising risk of a deep economic downturn is emblematic of the vexing dilemma facing developed market central banks the world over.
In the UK, the situation is especially acute. The nation’s cost of living crisis is among the worst in modern history and political tumult only adds to the uncertainty facing UK households.
Public opinion of the bank was negative in May for the first time, as citizens expressed concern about the BoE’s capacity to control inflation (figure above).
Amid the jostling to replace Boris Johnson as prime minister, Liz Truss took aim at monetary policy. At one point, her attempts to scapegoat the BoE manifested in the misguided suggestion that the Bank of Japan is an example of monetary “best practices,” a contention some economists were quick to lampoon. Given the BoE’s fairly strict mandate, there’s not a lot Truss could do, but some worry she many attempt to establish money targets (for example) without a full understanding of potential side effects. Others have suggested banning QE.
Speaking of QE, the BoE on Thursday said that after several weeks of deliberation following a staff review initiated in May, the bank is “provisionally minded to commence gilt sales shortly after its September meeting, subject to economic and market conditions.” So, the BoE may begin to actively sell UK government bonds next month.
Earlier this year, the bank ended reinvestments and unveiled plans to sell the corporate bonds it holds. Gilt sales, should they go ahead, will be guided by three principles: Bank Rate remains the primary active policy tool, market functioning can’t be disrupted and sales will be “relatively gradual and predictable.”
If you’re inclined to criticize the bank for tightening aggressively into a recession policymakers now openly expect and predict, do note that not hiking risks currency depreciation in the face of a dollar benefitting from Fed hikes. The pass-through from a weaker pound could exacerbate inflation. Indeed, it already has.
I’m not sure there’s much utility in lamenting this situation any further. It’s very troublesome, to put it politely. The UK is, arguably, in the worst shape among developed markets grappling with an inflation crisis that’s largely out of monetary policy’s hands.
Although the BoE emphasized that policy isn’t on a pre-set course, it also retained the “forceful” language from the June statement. “It’s our job to get inflation back down to 2%,” the bank said Thursday. “So we have raised interest rates.”
The UK economy is expected to spend five quarters in recession. Once the downturn begins later this year, households won’t see the light of day until 2024, according to the bank. Fortunately, their projections are subject to sizable revisions.